LoopNet Investigates Some Common Misconceptions That May Make Buyers Wary of Bidding
In real estate, the word “auction” might evoke negative images of a distressed money pit that will end up being more trouble than it’s worth. In truth, however, buying a property through an online commercial real estate (CRE) auction is an increasingly prominent avenue by which an investor can acquire property, and the process offers unique benefits for buyers and sellers.
“The online auction process has really evolved, especially in the last three to five years. At first both buyers and sellers were wary of it, but now they’ve become accustomed to the process and its advantages,” said Steven Silverman, senior vice president, investment advisory services at Detroit-based Friedman Real Estate.
LoopNet spoke with auction platform experts and brokers specializing in the sales method to tackle some common misconceptions investors might have about auction properties, and how they can capitalize on the benefits the investment tactic can offer.
“An auction is a sales tactic, it’s a way of selling, a way to trade real estate, the same way hiring a broker to sell your asset is a tactic.”
Steven Jacobs, president, Ten-X
Myth #1: All Auction Properties Are Distressed
While today’s online CRE auction marketplace is diverse, the assumption that most auction properties are distressed is rooted in some truth. Online auction sites — such as Ten-X Commercial, which was purchased this year by CoStar Group, the publisher of LoopNet — found success during the Great Recession when the financial crisis caused numerous commercial real estate properties to become distressed assets, and savvy investors were snapping them up for a steal.
“In the first few years of the business, about 80% of Ten-X’s business dealt with distressed assets. After seeing the success of online auction sales, we expanded to include private client sellers and built partnerships with brokers [as the market recovered],” said Ten-X President, Steven Jacobs. “Now the business is the inverse — it’s about 70% private client revenue and only 30% distressed [assets].”
In fact, some properties listed for auction are thriving. The Elk Run Inn in Craig, Colorado, for example, which goes up for auction on Ten-X on October 19th, has seen a year-over-year increase in room revenue from the year prior, even as hotels have suffered from lack of travel during the pandemic.
Just like in the sale of traditional net lease assets such as dollar stores and fast-causal restaurants that can offer investor appeal, it can be common for auction properties to come with a tenant already in place. Investors can buy multifamily properties that are already occupied, such as this five-unit Baltimore, Maryland, property that’s currently at 90% occupancy, or a single-tenant retail building like this standalone Best Buy in Kohler, Wisconsin, where the company has occupied the space for 15 years and has a lease running through 2023.
Are there still distressed or foreclosed properties up for auction online? Of course. Jacobs said that today, a little less than a third of properties listed on Ten-X are financially compromised, which can offer investors a value-add opportunity to purchase a property at a discount from market prices. As the economy reels from the pandemic and its impact, the market will likely see more distressed properties come up for sale.
Myth #2: Auctions Are a Seller’s Last Resort
So, if all auction properties aren’t distressed, you might ask why a seller would be auctioning off a property instead of going with a traditional sale. The assumption here might be that they are desperate to dispose of an asset, or there is something wrong with the property that’s causing other buyers in the market to look the other way. In reality, there are many reasons a seller might choose to go the auction route, and experts agree the tactic can have many benefits for all parties involved.
Friedman’s Silverman oversees around 50 auctions per year and his Detroit-based firm has brokered auction deals in nearly 40 states. He notes that sellers are attracted to auction sales primarily for the speed of the transaction timeline and the certainty of close.
“Especially with the current state of the market due to the pandemic, we have seen more deals fall through. In the auction world, you have a drop-dead date, and once a buyer signs up online and places a bid, they put forth a nonrefundable deposit. At that point, there is much more surety of the deal closing when there is nonrefundable money at hand,” Silverman said.
With Ten-X deals specifically, buyers are bound by contract to close within 30 days of winning the bid. In the traditional market, Silverman said that interested buyers can sometimes submit an offer, and then “find out they can’t get financing and walk away from the deal. With an auction, there’s a 95% or so chance of a deal closing. In the traditional market, it could be 50-50.”
Not only is the deal more likely to close in an auction, but it does so at a much quicker pace. A traditional sale timeline can take upwards of six months, according to Jacobs, when you include marketing, outreach, underwriting, price negotiations, due diligence and, in most cases, a buyers’ final attempt at a re-trade on the deal before closing. “It’s a long process, and it can be bumpy,” he said.
With a Ten-X auction sale, the process is condensed to about 90 days — a 45-day marketing and due diligence period, a 2- or 3-day auction and a 30-day closing period — and winning bidders put down a 10% nonrefundable deposit, an amount that Jacobs said is consistent with most offline real estate deals, too.
“There are reasons to go the auction route, and there are reasons to sell in the traditional market. Each asset will lend itself differently to those options, but [our firm] has seen a lot of success with auction sales,” said Steve Leslie, vice president, capital markets of JLL’s Hotels & Hospitality Group in Atlanta. In the past two months, Leslie says his team has closed, or is under contract on, four properties through online auctions, totaling $60 million in proceeds.
“Auctions are definitely not a last-resort option that [sellers] only use when a deal falls through by traditional means, and it doesn’t mean something is wrong with the property or that it’s in distress,” said Jacobs. “An auction is a sales tactic, it’s a way of selling, a way to trade real estate, the same way hiring a broker to sell your asset is a tactic. It’s an expedited, accelerated tactic compared to many options out there.”
Myth #3: Auction Properties Are Always Cheaper
It’s easy to assume that buying a property at auction means you can get a great deal at a discount, and that certainly can be true. But it’s not always the case, and, in fact, some assets even sell for higher than their appraised value. Sellers will usually set a reserve price, or the lowest amount they’re willing to sell the property for, and investors participating in an auction should be prepared for the possibility that a winning bid can end up being higher, lower or right in line with market expectations. According to Jacobs, all three of these scenarios occur with auction properties on Ten-X.
Sometimes, as Silverman has seen, an auction can dictate the value of an asset in a process he called “market-driven pricing.”
“We are currently under contract on a family-owned property — their father developed it, they didn’t know what it was worth, and said that a couple of different firms had given them different [appraisals]. We said, ‘why don’t we take it to auction and let the market dictate what the property is worth’,” he said. “A seller sets the reserve where they feel comfortable selling, and at the end of the day the market will really tell [them] what [their] property is worth.”
The gamified psychology of auction bidding may be what drives up the final sale price of some assets well above a seller’s reserve, as bidders will often wait until the final moments of an auction to start submitting their offers.
“I’ve had a number of deals where bids were slowing down, and then we lowered the reserve, hit it, and then we had four more groups jump in and bid it up another million,” said Leslie, who works primarily on auction deals of hospitality assets in the $15-$20 million range.
For buyers, the auction process allows a lot of transparency into an asset’s price point.
“Buyers can see the price in real time and decide to match or raise a bid to at least have the option of being the winning bid. In a traditional sales process, you submit blindly and go back and forth with negotiations and offer rounds, but you don’t know what other buyers are submitting,” said Leslie. “You never know [with a traditional sale], ‘if I had just bid $100,000 more, I could have won.’ Transparency in the bidding process is a big advantage of auctions [for investors].”
Myth #4: Auction Bidders Buy Blind
In an online auction, a single exterior photo may have you worried that you’ll end up buying a distressed property with deferred maintenance, need for significant upgrades or a major issue obscured from view. In reality, most auction sites provide ample documentation and transparency. Ten-X, for example, offers a robust due diligence vault (which is accessed after signing a confidentiality agreement), and each property on the site is represented by a broker who works with interested buyers, helps them learn about the property and provides tours of the asset.
Unlike a traditional sale, where buyers conduct due diligence after an offer contract is signed, in an online auction, the due diligence period actually occurs before bidding begins. During the 45 days prior to a property’s auction date on Ten-X, buyers can review an offering memorandum, market data, financial and operating statements, purchase agreements, pictures and videos, environmental and property conditions reports and title and insurance documents.
“Everything is posted in the due diligence vault beforehand, so auction buyers really need to [familiarize themselves with those documents] and get comfortable with [the property] before placing a 10% hard money deposit down, if you end up being the winning bid,” said Leslie.
Jacobs did clarify that with a Ten-X auction, you are buying the property “as is.”
“We strive to provide buyers with the best and most comprehensive due diligence materials available to us,” said Jacobs. “Sometimes — very rarely, but it has happened in the past — a buyer finds something problematic after winning the bid, say for example, the seller had a lawsuit occur during closing that wasn’t represented. So, there can be risk for a buyer in a deal.”
Tapping the expertise of broker representatives, who partner on every Ten-X deal, is a valuable resource for buyers to glean more information and tour the property in person before bidding.
“I always prefer to work with buyers who have actually visited the property. There are instances where a buyer will go into a property once they’ve won the auction and put their deposit down, and then attempt to re-trade the deal once they’ve seen it, even though they have a non-negotiable contract. They were given everything up front, and they just didn’t visit the property,” said Silverman.
Silverman also emphasized that communication is key, especially for investors who are just getting their feet wet.
“For some reason a lot of buyers, especially first-time buyers, are hesitant to reach out to the brokers and the client managers working these deals,” he said. “[Buyers] should leverage the contacts available to them and the brokers who are third-party partners on this platform; and the more information they can get from the brokers who really know the deal intimately, the better. Open communication is really important in these deals.”
https://www.loopnet.com/learn/debunked-four-myths-about-cre-auction-properties/1132237437/